Spillovers from United States Monetary Policy on Emerging Markets: Different This Time?

Author/Editor: Jiaqian Chen ; Tommaso Mancini Griffoli ; Ratna Sahay

Publication Date: December 24, 2014

Summary:The impact of monetary policy in large advanced countries on emerging market economies—dubbed spillovers—is hotly debated in global and national policy circles. When the U.S. resorted to unconventional monetary policy, spillovers on asset prices and capital flows were significant, though remained smaller in countries with better fundamentals. This was not because monetary policy shocks changed (in size, sign or impact on stance). In fact, the traditional signaling channel of monetary policy continued to play the leading role in transmitting shocks, relative to other channels, affecting longer-term bond yields. Instead, we find that larger spillovers stem more from structural factors, such as the use of new instruments (asset purchases). We obtain these results by developing a new methodology to extract, separate, and interpret U.S. monetary policy shocks.

Gold and Silver Prices in 2015

Precious metals haven't grabbed dramatic headlines like oil and gas have.But their story is no less exiting. And the metals remain a fundamentally critical part of the global economic and strategic landscape.Indeed, gold and silver took roller coaster-like rides throughout the year, both screeching towards their respective price lows before bouncing, albeit cautiously, ahead.With the benefit of hindsight and the value of foresight, it's time to look at how gold and silver acted in 2014, and what we can do to profit in 2015.Let's start with the yellow metal…

Gold Will Bounce Back Quickly

As you follow along with the graph, note that gold started out with a bang, bottoming around $1,195 December 19, 2013, then surging upward 12% to $1,390 by mid-March. It then headed back to the $1,300 level, and meandered sideways between $1,250 and $1,350 until mid-year.The U.S. dollar began a strong climb from July onwards, likely in anticipation of the Fed ending its asset purchase program in October, as it ultimately did.By November the SPDR Gold Trust ETF (NYSE Arca: GLD), the largest gold ETF, saw its gold holdings at six-year lows. Gold had become almost universally hated, which may well have marked the bottom.And then it embarked on a new rise…One of the biggest positives is how gold held up over the recent months: as oil prices plunged 27% from early November into mid-December, gold climbed by 7%.Not even news of the defeat of the Swiss Gold referendum held it back.Then India, battling for top gold consumer spot with China, relaxed some of its import restrictions on gold, making it more attractive during the traditional wedding season, and helping to push its price higher.Chinese gold demand remains robust as well, and is expected to grow substantially again in 2015.Will 2014 eventually prove to define the bottom in gold?The odds of that are improving. Even if the U.S. dollar continues to show relative strength, I believe the fundamentals are in place for gold to reach back into the $1,400 to $1,500 range by this time next year.

Silver Will Take Longer – but It Will Be Worth the Wait

Silver's had it rougher than gold which, thanks to its nature, is to be expected.While gold is off about 1% so far this year, silver's given up about 12% – way more than it typically would.But not everyone is selling…

In the shadow of a group of enormous smokestacks and abandoned foundries, a peeling sign welcomes visitors to the Wenxi Steel Industrial Park.

Highsee stopped paying its 10,000 employees six months ago. Local officials estimate the plant supported indirectly the livelihood of about a quarter of Wenxi county's population of 400,000. Highsee was the biggest privately owned steel mill in Shanxi, accounting for 60 per cent of Wenxi's tax revenues. For those reasons, the local government was reluctant to allow the company to go out of business, even though it had been in serious financial difficulties for several years.

"By 2011 Highsee was already like a dead centipede that hadn't yet frozen stiff with rigor mortis," says one official who asks not to be named because he was not authorised to speak to foreign reporters. "More than half the plant shut down, but it was still producing steel even though its suppliers wouldn't deliver anything without cash up front and it was drowning in debt."

In the past month alone Chinese media have reported on at least nine large steel mills that appeared to be suspended in limbo after halting production but which are forbidden from going formally bankrupt.

"There are large numbers of companies across China that should go bankrupt but haven't done so," says Han Chuanhua, a bankruptcy lawyer at Zhongzi Law Office, a Beijing legal practice. "The government doesn't want to see bankruptcy because as soon as companies go bust, unemployment spikes and tax revenues disappear. By stopping companies from going bankrupt, officials are able to maintain the illusion of local prosperity, economic growth and stable taxes."

The outstanding volume of non-performing loans in the Chinese banking sector has increased 50 per cent since the beginning of 2013, according to estimates from ANZ, the Australian bank, but the sector-wide NPL ratio remains extremely low, at just over 1.2 per cent.

In private, however, senior Chinese financial officials admit the real ratio is almost certainly much higher, obscured by local governments trying to prop up companies.

Rebalancing Chinese Style

As part of China's rebalancing effort, growth must slow (or an even bigger crash will come later), and shadow banking losses recognized. So far, all we see is the slowdown in growth.Even then, China recently cut interest rates hoping to keep the illusion alive (as some might see it), or smooth the transition (as others might see it).Regardless how one sees it, these closures are at the back end of a collapse in commodity prices as China moves from an investment (malinvestment) driven pattern of growth, to a consumer-driven pattern of growth.The transition will not be easy. The SOEs (state-owned-enterprises), the regional governments, and all those who got wealthy from the prior boom will not let go easily.Nor it seems will the central government. Failure to recognize absurdly high deposit rates are proof enough.

There are not many executives who have asked their boss three times whether they should be fired and survived. Maria das Graças Foster, chief executive of Petrobras, Brazil’s crisis-stricken state-owned oil company, says she’s one.

She has offered her resignation to Dilma Rousseff, Brazil’s president, on multiple occasions in recent weeks but her close friend of more than a decade has stuck by her — so far.“The president thought I should stay,” Ms Graças Foster told reporters this week.

Petrobras, the pride of Brazil in 2007 after it announced the world’s largest offshore oil discoveries in decades, is today in danger of becoming a pariah among investors and a national shame for Brazilians.

The company has been thrown into disarray by an investigation by Brazilian police and prosecutors alleging that former senior executives, construction companies and politicians of Ms Rousseff`s Workers’ party-led ruling coalition creamed billions of dollars off Petrobras’ contracts.

This allegedly took place under the noses of Ms Rousseff, who was the company’s chairman until she took office in 2010, and Ms Graças Foster, who has led Petrobras since 2012.

Although neither are accused of direct involvement, the scandal has sparked an investigation by the US Securities and Exchange Commission and led the dual-listed company’s auditor, PwC, to refuse to sign off on its accounts until Petrobras has conducted its own inquiry.

If Petrobras is unable to satisfy PwC’s concerns and release audited financial results by April 30, the company, one of Brazil’s biggest corporate borrowers with debt estimated by Moody’s credit rating agency at $170bn, could trigger a technical default.

It is all part of a perfect storm facing the company after what critics say are years of misuse of Petrobras by the government as an instrument of industrial and monetary policy at the expense of minority shareholders.“At the end of the day, all of this is happening because the PT (Workers’ party) has fostered monopolies and, to a certain extent, cartels which generate inefficiencies and an atmosphere that is conducive to corruption,” says Adriano Pires, founder of the Brazilian Centre for Infrastructure and energy adviser to the opposition PSDB party.With revenue of more than $140bn in the 12 months to end of June this year and 86,000 employees, Petrobras produced 2.3m barrels of oil equivalent per day (b/d) domestically last year. The company is also undertaking the world’s largest corporate capital expenditure programme, valued at up to $221bn over five years, to exploit its “pre-salt” discoveries, so-called because they lie under 2,000m of the compound up to seven kilometres beneath the waters of Brazil’s southeast coast.Ever since Rio de Janeiro won the bid to host the 2016 Olympics five years ago, the game’s organising committee has faced growing scrutiny. Work has only just begun on the Deodoro Olympic Park, the site of the sailing events in Guanabara Bay and still dangerously polluted, and shoot-outs in the city’s favelas are as common as ever.But since the discovery of the pre-salt, everything has gone wrong for Petrobras, critics say. To pay Brasília for the rights to the discoveries, it held the world’s largest share offering in 2010 amid controversy over valuation. The government also made it the sole operator of the pre-salt fields, overburdening its balance sheet and reducing competition. It was also forced to adopt an expensive local content programme and to subsidise domestic fuel prices to help the government control inflation.The company has routinely missed forecasts and production has declined since 2011, due to delays in equipment delivery and other problems. “Petrobras has broken many promises in the past. Production targets were consistently missed,” said Credit Suisse in a report. The result of this and the corruption allegations is that Petrobras has lost 73 per cent for investors in the past four years, making it the worst-performing major oil stock, according to Bloomberg.Domestic production is expected to turn around this year with forecasts it will rise to 2.5m b/d, the first step to doubling output by 2020. But now Petrobras must deal with the twin challenges of the corruption investigation, which is cutting off its access to capital markets, and the falling oil price, which threatens the viability of pre-salt. To avoid violating covenants associated with its $57bn in capital market debt, Petrobras must release independently audited financial results within 120 days of the end of this year. If it fails to do this, it has another 60 days — to June 30 — to “cure” the default.Analysts say the company, which has begun an internal investigation, does not need to wait for the criminal procedures to conclude to produce audited accounts. It could instead provision for any likely losses by taking a writedown on its capital. This has been estimated by Morgan Stanley at up to R$21bn assuming that projects were overstated in value by 5 per cent.“This is not going to be a cash item,” said Nymia Thamara Cortes de Almeida, credit analyst at Moody’s. That is important because Petrobras, with its huge capital expenditure programme, has lost direct access to capital markets while it is waiting to release its audited results, leaving it vulnerable to a cash crunch given its huge capital expenditure programme. Most analysts believe the company has enough cash and other resources to last until the middle of next year but it cannot afford to delay capital expenditure as this will slow its increase in production and undermine its ability to repay its enormous debt load.“An average delay of 12 months or more in bringing new production units online could significantly weaken Petrobras’s standalone credit quality and result in negative rating actions,” said Fitch Ratings analyst Lucas Aristizabal.The other concern for Petrobras is the 45 per cent fall in the oil price to about $60 per barrel in recent months. Although Brazil is a net oil importer, if the price falls any lower than $50-55 a barrel, the entire pre-salt project becomes unviable, analysts say.“The problem is when you invest with the oil price at one level and have to sell with the price at another level,” says one analyst at a foreign bank in São Paulo who, like many of his colleagues, now refuses to be quoted on the company.These challenges are fuelling expectations that the government will need to bring fresh blood into the management at Petrobras and replace Ms Gracas Foster. Mr Pires says market-friendly candidates would include Murilo Ferreira, chief executive of Vale, the iron ore miner, and Henrique Meirelles, a former central bank president.“They need to bring professionals from the market to be chief executive and chief financial officer, not Petrobras insiders,” he says.

ON DECEMBER 22nd an odd couple—Nicaragua’s left-wing government and a Chinese-born telecoms magnate—say they will begin the realisation of a dream that has captivated Nicaraguans for generations: the construction of an inter-oceanic canal to rival Panama’s. According to Manuel Coronel, an octogenarian who runs the canal authority, their intentions are now beyond dispute. “When the bride and groom set a date, you know it’s serious,” he says.But ask Mr Coronel just where construction will begin and who will pay for it, and he has no answers. Neither does HKND, the Hong Kong-based company run by Wang Jing, which is to build the $50 billion waterway. The project has been shrouded in secrecy since Nicaragua’s National Assembly awarded a 50-year concession to HKND in 2013. No feasibility study, environmental-impact report, business case or financing plan has yet been released. Instead come platitudes from the Sandinista government of Daniel Ortega about how it will bring a jobs bonanza and end poverty.So far, it has brought as much fear as hope. Since Chinese-speaking surveyors, backed by Nicaraguan soldiers and police, began assessing land and houses along the canal’s proposed 278km (172-mile) route a few months ago (see map), peasants fearful of their land being expropriated have taken to the streets 16 times. On December 10th several thousand, shouting “We don’t want the Chinese”, protested in Managua, the capital, despite police efforts to keep them in their villages, activists say. Boatmen in Punta Gorda on the Caribbean coast have refused to ferry heavy machinery to be used to begin construction, fearing their livelihoods will be harmed.In November the Nicaraguan Academy of Science convened a panel of experts to demand clarification of the impact of dredging sediment along a 105km stretch of Lake Nicaragua. They said it could damage drinking water, irrigation systems, fishing and biodiversity in one of Latin America’s greatest tropical lakes. Engineers say the proposed canal, which is aimed at enticing bigger ships than those now able to cross between the Atlantic and Pacific, could run massively over budget and provoke further widening of the Panama Canal, which would ruin its business case.Many still doubt it will ever be built. Carlos Fernando Chamorro, editor of an anti-Ortega publication, Confidencial, says the only groundbreaking on December 22nd will be for an access road to a proposed port near Brito, on the Pacific coast, at what is expected to be one entrance to the canal. Some experts think the port, a proposed airport nearby and a free-trade zone may be as far as the canal gets.But the case for a canal may not rest only on tolls and jobs. China may see it as a strategic route to the Atlantic, says Evan Ellis of the United States Army War College. If so, it might be built after all.

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.